How is this strategy?

raymondred

So I do my own savings & investments and SIPP and have been reading about withdrawal rates and the impact of a market crash or entering a bear market just after retirement.

My investments will fund half my income when I retire so I can accept some risk with going for growth in my investments. So my long-term preference is to be invested 80/20 equities/bonds. But I want to balance the risk of an equity market crash just after retirement. So...

I will hold 12 months cash for living costs so that I could if necessary avoid withdrawing anything from my investments for 1 year. I will also hold cash for investing as follows...

I will change my investment mix to 15% cash, 15% bonds, 70% equities and rebalance as necessary.

The 15% cash will allow me to top up a fall in up to 20% in equities to return them to the original starting value. Importantly it would allow me to buy cheap rather than sit on the sidelines missing a buying opportunity and seeing my investment fund size decline. I would buy equities the first time they decline by 10% or more from my post retirement peak, at which point I would use half of the cash to buy equities. Exact figures would depend how far equities had risen prior to the fall but I would then be approx 75% equities, 15% bonds, 8% cash. If markets recover that’s good. But if equities fall further I would continue to buy until the investment cash was exhausted. At that point I would be left with 85% equities and 15% bonds. I can then rebalance to 80% in equities and 20% in bonds.

The point of this is to have a plan to cover the scenario of a sharp fall in equities soon after retirement. The only downside I see is that the cash element is eroded by inflation, say 2% p.a., so if equities never fell by 10% for 5 years then the 15% unused cash will have lost about 10.5% compound value. But if equities have not fallen, they should have risen (unless the markets are ‘sideways’ for 5 years solid!) and as equities are 70% of the portfolio they only need to rise 2.2% in 5 years to offset the amount lost to inflation by holding cash.

This is not about just rebalancing, more about how to hedge against a sharp fall in equities - and take advantage of it - in the years straight after retirement. How does this strategy sound? Are there any better approaches?

atush

I would hold at least 2 years of income in cash, as one year might not be enough time for a recovery? Many say 3-5, I was thinking of 3.

Esp if you using are cash in your investment fund to buy investments during a crash at a cheaper price.

raymondred

atush wrote: »

I would hold at least 2 years of income in cash, as one year might not be enough time for a recovery? Many say 3-5, I was thinking of 3.

Esp if you using are cash in your investment fund to buy investments during a crash at a cheaper price.

I could hold more than 1 years living costs as cash. Although no, this would be separate from the cash for investing.

atush

Yes, that is what I meant, at least 2 years living cash (plus an emergency cash fund as normal)in addition to investment portfolio incl 15% cash.

jamesd

One year if just using it as the source of your living money while it's topped up by your investment income as that arrives would be good. Then adjust income level if it gets depleted below say 50% due to a prolonged drop in income.

I tend to suggest two or sometimes three years of the investment income for those who are retiring at younger ages because that increases the time and depth of income drop that can be ridden out without a need to sell any investments.

For your purpose three or perhaps more years might be appropriate to give you the funds to reinvest.

I have some reservations about your 10% investment buying trigger. The big risk is a large drop that does not recover for a long time. Your trigger would have you buying while a drop has further to go and in this scenario that's a bad idea because that's the same money you're relying on to ride out the situation. To limit the ongoing downside potential you might consider a 20% trigger instead of 10%.

You might also consider selling some investments after a 10% drop that is sustained for a month with a view to possibly buying back later if it becomes a large decline. This will have you selling during quite common volatility, though, but it would avoid depleting your cash. It'll decrease returns in the more normal case, but that's a price to pay for protection.

Another measure would be to buy options that are quite far out of the money, perhaps 30% drop sort of level. That would protect you from the bigger drops, at the cost of the ongoing regular purchasing cost for the options.

raymondred

jamesd, all good suggestions thank you.

Another approach could be instead of holding cash, 70% equities and 30% bonds, and if the equities fall 10%, instead of just rebalancing to 70%:30%, to change the allocation to 80% equities 20% bonds. If equities fall further, say 20% from peak trigger, sell bonds and buy equities to 90% equities 10% bonds.

I'm not sure if this would be any more effective as a strategy to ensure the portfolio recovers it's full value quicker if there is an equity market crash soon after retirement.

kidmugsy

raymondred wrote: »

yto ensure the portfolio recovers it's full value quicker

"ensure" isn't a word I'd use about investing.